Verint Systems, Inc.
- Verint Systems Inc. (VRNT or “the Company”) is a call center software provider which has fallen far behind the industry’s evolving technological standards and which is making up for slow growth with aggressive M&A and dubious accounting. While Verint reported 8% sales growth in FY19, we believe that, netting out M&A contributions, FX, and the effects of ASC 606, organic growth – which the Company never discloses – was negative. Despite Verint spending ~$1B on M&A since FY15, sales have grown at only a 2% CAGR, and FCF / share has declined at a CAGR of 1%. Management nevertheless rewards itself with compensation 3x that of its most comparable (but far healthier) peer, hitting comp targets through nonsensical earnings adjustments which appear nowhere in its filings except deep in the appendices of its proxy statements. Management’s questionable conduct persists over calls for improved governance and transparency, which have culminated in a proxy battle with long-time shareholder Neuberger Berman. Its disregard for shareholders concerns us given its deep connections with other infamous frauds and history of engaging in dubious business practices to flatter reported results. Even then, bulls interpret reported growth as a sign that the purported cloud-oriented strategy is working, leaving VRNT trading at all-time high multiples even as organic growth sputters and ASC 606 benefits anniversary.
- A Poor Business Lagging Peers: Verint’s core business is “customer engagement solutions” – a euphemism for call center software. Industry incumbents Verint and NICE were once near-duopolists, but NICE acted on the industry’s shift to the cloud much more effectively, and it continues to grow alongside technologically-savvy upstarts at a high-single-digit rate, while Verint suffers from the industry’s rising technological demands and lower barriers to entry.
- Aggressive Spending On Low-Quality M&A Obfuscates Organic Growth And Appears To Create A Cookie Jar For “Beat & Raises”: Since FY15, Verint has spent ~$1B on M&A. KANA, its biggest acquisition, failed spectacularly in our view, as sales growth immediately turned negative once the acquisition was anniversaried. Verint has continued to pursue smaller tuck-in acquisitions since, but most deals go unannounced, and are not explicitly named in SEC filings. We believe that, after taking into account M&A, FX, and the effects of ASC 606, organic growth was in the low single digits in FY18 and negative in FY19, far below reported top-line growth in the high single digits. Last quarter, management raised guidance by just $20M upon acquiring ForeSee Results, Inc., whereas court filings indicate that ForeSee was generating ~$80M in sales at the time of the bankruptcy of its former parent, Answers Corp. (2016), and was projected to grow to $130M by this year. We believe that subsequent sales growth characterized as organic was largely driven by this and other acquisitions, and that its underreported inorganic sales contribution created a “cookie jar” which Verint used to beat Q4 and raise FY20 guidance.
- Key Executives With Dubious Pasts: Dan Bodner has been CEO of Verint since its founding in 1994. For much of the 1990s and 2000s, it was a subsidiary of Comverse Technology, whose CEO, CFO, and GC orchestrated a massive options backdating scandal during this time. All three sat on Verint’s Board and were the sole members (with Bodner) of key Board committees. A later investigation found that Verint had carried out aggressive business practices under Bodner to decrease sales volatility and inflate reserves. CFO Douglas Robinson worked for Computer Associates for 17 years through the 1990s and 2000s, including stints as a senior member of the finance department. CA was similarly shown to have engaged in aggressive revenue recognition practices to inflate sales and earnings. Though Robinson was never implicated, his close association with CA’s finance department at the time of the fraud concerns us.
- Aggressive Accounting Measures And Non-GAAP Add-Backs Inflate Performance: We find it curious that, in FY19, for the first time, management announced that it would capitalize commissions. Whereas Adj. EBITDA and Non-GAAP Income were reported to have grown by 16% and 18% in FY19, respectively, growth in these metrics would have been just 2% and less than 0% when capitalized commission costs alone are added back to expenses. We also estimate that ~11% of Adj. EBITDA and ~45% of Non-GAAP Net Income are attributed to add-backs which we consider unusual or otherwise unjustifiable. As is the case with many companies researched by Spruce Point, Verint shows a widening gap between unadjusted and adjusted EBITDA, suggesting that management is growing increasingly aggressive to present attractive results as organic sales and earnings continue to underperform.
- Questionable ASC 606-Related Accounting Changes Inflate Sales And Earnings Growth: ASC 606 adoption boosted Verint revenue by $47M (5%) and net income by a massive $51M (75%) in FY19. This is entirely out of line with peers such as NICE, whose revenue declined due to ASC 606, and whose net income went largely unaffected. Management also claims to have made changes to its business practices in anticipation of its adoption of ASC 606 – something we find oddly suspicious – and, in FY19, to have double-counted revenue which it had recognized as revenue in prior periods. Of course, it made all of these changes with far less transparency than peers such as NICE, which was not only far less aggressive in its application of ASC 606, but which, unlike Verint, provided clear reconciliations against its financial presentations under ASC 605 standards.
- Non-Transparent Earnings And Cash Flow Adjustments Help Management Achieve Comp Targets: Performance metrics used by Verint to determine management compensation are riddled with questionable add-backs which are included in no other financial metrics reported by the Company. Management inexplicably adds net interest expense back to operating cash flow to achieve its cash flow targets. Also included in its adjustments are phantom “non-recurring payments” which appear nowhere else in Verint’s financial statements. Further, management recognizes material contingent consideration write-downs on an annual basis, thereby increasing its performance metrics as these reversals boost Company earnings. In so doing, management effectively gives itself credit for its poor acquisitions failing to meet their financial targets. We wonder how Verint’s acquisitions could be underachieving their targets when management appears to understate their prospective inorganic sales contributions.
- Proxy Fight With Neuberger Reveals Atrocious Governance: Neuberger Berman sees that Verint is struggling to keep up with industry-wide technological change and has pushed it to add new Board members and focus on the cloud. Management has been playing coy with Neuberger for months: it fails to respond to requests in a timely manner, has Neuberger-recommended Board members interview with employees who report directly to the CEO, never appears to seriously consider recommended Board members in the first place, and offers bizarre compromises to Neuberger in an attempt to settle the dispute. While stating publicly that it is focused on the cloud, management tells Neuberger that the cloud is not a primary focus, and that “customers are not interested in the cloud.” We see management’s double-speak, evasiveness towards Neuberger, and generally irregular behavior a significant red flags.
- Reported Cloud Revenue An Inappropriate And Non-Transparent Measure Of Cloud-Related Sales: Management recently began to report a number of proprietary cloud sales metrics as investors such as Neuberger demand more transparency on cloud-related growth. Company disclosures are inconsistent regarding the fact that its reported cloud sales figures include sales from term-based licenses, for which it can now more aggressively recognize revenue under ASC 606. Accordingly, its cloud sales metrics present a skewed view of its “recurring” cloud-related sales, which will be lumpier than investors currently believe and which could easily disappoint in the near future if the pace of customer adds slows. Industry experts generally do not consider such term-based arrangements to accurately represent true cloud / SaaS revenue, which is more typically arranged in subscription-like agreements, and which therefore produces a steadier and less volatile stream of revenue than would Verint’s term-based contracts for its “hybrid cloud” services.
- Insiders Bailing As VRNT Is Up 45% YTD And Trading Near All-Time Highs: The Street believes that VRNT trades at a ~35% discount to peers based on an improper view of Adj. EBITDA and net debt. Even then, the avg. analyst price target of $66 yields just 8% upside. After restating EBITDA for questionable add-backs and newly-capitalized expenses, and after removing non-transparent restricted cash items from liquidity, we find that VRNT trades at almost exactly its peer median multiple, despite contracting organic sales and stagnant cash flow. Meanwhile, insiders are dumping the stock just as it approaches all-time highs (up 45% YTD). We believe that its current multiples – its highest in recent history, and comparable to high-quality take-outs SAAS and BSFT – are unsustainable as M&A fails to grow cash flow, as it falls further behind BPO software peers and out-of-favor with SaaS-oriented investors, and as it laps FY19 ASC 606 tailwinds. We value the slow-growing Company at an EV/EBITDA multiple of 8-10x for a price target of $17-25, yielding 60-70% downside.